All Forum Posts by: Edward Schenkel

Five Key Legal Issues in Wholesaling

Wholesaling is becoming a more popular way that investors do deals. Wholesaling, like any real estate investment, has positives and negatives aspects. As a lawyer who has handled a fair amount of wholesale deals, I made a list of five legal issues that every investor should be aware of before getting involved in a wholesale transaction.

1.Make Sure the Contract is Assignable

Not every contract is assignable, which is the mechanism that wholesalers use to sell their interest in the contract for a fee.Every county in Connecticut has a slightly different purchase and sale agreement, and many have also been tinkered by real estate agents and attorneys. Moreover, I see more investors using forms they have downloaded from various websites. If you are going to wholesale a contract, you need to make sure the contract is clear that you, as the Buyer, have the right to assign the contract to anyone in your sole discretion. If there is no such clause, arguably you may have to perform and you cannot sell the contract. Make sure the contact has a clear provision that you have the right to assign your interest.

2.LLC

Any real estate transaction has risks. Wholesaling a deal is no different. Therefore, it benefits you and mitigates risk if you enter into the contract with a limited liability company instead of as an individual. In the event that something goes south and there is litigation, it is much better if your LLC is a party and not you, and hopefully your LLC does not own many assets.

3.Due Diligence Items

Due diligence items in the contract are essential even in a wholesale deal where you ultimately will not close the deal yourself. Yet, you should include the same due diligence items in the contract as if you were planning on purchasing the property. These due diligence items at a minimum are an inspection contingency clause and a mortgage contingency clause. I always advise clients wholesaling that they should push the contingency dates out as far as possible to allow you time to find a new buyer and give the new buyer enough time to do an inspection and/or apply for a mortgage. Keep in mind that the new buyer who you wholesale to will essentially step into your shoes and will have the same due diligence rights as when you signed the contract, so think carefully about them with the help of an attorney.

4.You may have to Perform

If you cannot find a new buyer by the closing date or the new buyer cannot get a mortgage, you may have to close on the property depending on how you draft the contract. If the Seller will not allow an exit provision if you cannot wholesale the contract, you will have to close or breach. If this is unacceptable, make sure there is a contingency clause that addresses this.

5.If you are the Seller, Make Sure Buyer #1 is on the hook if Buyer #2 does not perform

The Seller may allow you to assign the contract to a new buyer but insist that if that new buyer does not close, you are then required to close. When I represent sellers in wholesaling deals, I insist on this provision to protect the seller. Be prepared for this type of negotiation. Putting more money down may make the Seller more comfortable and not insist on such a provision (then you can seek reimbursement for the deposit from your new buyer).

YOUR BUILDER OR CONTRACTOR MADE A MISTAKE – WHAT CLAIMS CAN YOU MAKE?

Many clients have approached me inquiring about claims they can make against a builder or contractor that performs substandard work. Unfortunately, builders and contractors make mistakes all the time through human error, cutting corners, or hiring the wrong subcontractors for the job. When things go wrong, sometimes the work is not up to par with standards in the industry while other times there are blatant violations of the building, fire, or zoning code. Either way, defective work is very problematic for property owners, particular those who paid significant sums of money and do not get the results they bargained for. What types of claims can you make against a builder or contract who performs shoddy work?

1.Breach of Contract

As a preliminary point, it is a good idea to have a written construction contract with your builder or contractor to protect yourself. There are a number of essential provisions to include in such contract, however it is imperative to make sure the scope is properly defined both in the main body of the contract and by attaching an plans or specifications, if possible. Other important provisions include warranties and requiring the builder to maintain adequate insurance. It is a good idea to review the contract with an experienced attorney to make sure you are protected.

If there is defective work, a written contract will be vital in bringing a breach of contract claim, so you can claim the work is not in compliance with the contract. If the plans are made a part of the contract, failure to comply with the plans is likely a breach of contract in itself. Similarly, if certain materials are called out, failure to use these materials may be a breach in itself as well. Often, a provision is included requiring the builder or contractor to perform in accordance with industry standards. If there is defective work, arguably there is a breach of this provision as well.

2.Negligence

If a builder or contractor performs defective work, you also may be able to bring a negligence claim. You may be able to bring negligence claims against all of the subcontractors that performed the defective work, not just the general contractor. Suing all the subcontractors in a breach of contract claim is more complicated since you likely only have a contract with the general contractor or construction company.

In order to bring a negligence claim, you must show that the builder owed a duty of care, that duty of care was breached by failing to meet the standard of care, and that the breach was a proximate (foreseeable) and direct cause of the damages. A builder is held to be under a duty to exercise a degree of care which a skilled builder of ordinary prudence would have exercised under the same circumstances. Therefore, you will need to prove the hired builder did perform as a builder of ordinary prudence would have performed. At trial, you will likely need to call experts in the industry to demonstrate that your builder did not perform prudently and therefore breached the duty of care.

3.Breach of Warranty

You may also be able to bring breach of warranty claim against your builder for defective work, both express and implied warranted. An express warranty may be included in the contract by a builder in a construction contract, typically by making a representation about the quality of the work and providing a period of time in which the builder will fix any problems at no cost to the client. Often, a builder will provide a warranty that the work is performed in a workmanlike manner, meaning that it is up to industry standards. If the work is not up to industry standards, you may have a claim for breach of express warranty.

There are also statutes that create implied warranties in new construction contracts. There are four implied warranties in such contracts: (1) an implied warranty that the construction improvement is free from faulty materials; (2) an implied warranty that the construction improvement was constructed according to sound engineering standards; (3) an implied warranty to construct in a workmanlike manner; and (4) an implied warranty of habitability at the time of delivery or the time of completion of an improvement if not completed when deed is delivered.There are certain exceptions, however a breach of implied warranty is another claim you may be able to make against a builder for faulty work in new construction.

4.Misrepresentation

If the builder or contractor made a misrepresentation either in the contract or orally to you prior signing, you may also be able to make a claim for misrepresentation. For example, if a contractor represented it would include certain materials in the work performed and did not, this may amount to a claim of misrepresentation. A misrepresentation may also allow you to make another claim under the Connecticut Unfair Trade Practice Act, which allows recovery from businesses that engage in unethical, immoral, and/or unscrupulous conduct.

As you can see, there a number of different types of claims you should think about if your builder or contractor performed defective work. It is a good idea to think about filing multiple claims in a lawsuit in case one of them fails for one reason or another. Moreover, you may be entitled to additional damages for certain types of claims v. others, which will be discussed in another post.

@Mario Bellavia, yes I would be happy to help you with any questions, please reach out when you are ready to set up the LLC.

 Message me, I think I can help you. Or feel free to ask here. Thanks. 

@Mathew Berry, I may be able to help you. Please ask your question here or message me.

I have many clients who are investors who ask for information about setting up a Limited Liability Company to hold the property, which is always recommended to protect yourself. However, most clients do not ask the appropriate next question – do I need an operating agreement? If you have a partner or partners, I would strongly recommend it. An operating agreement spells out who has the authority to do what, what type of action requires a unanimous vote, what capital contributions each partner is contributing, how the company will take on new members, along with a number of other items. Addressing this now can prevent problems in the future.

I have litigated cases concerning partners who are fighting over how to manage the property or whether to sell the property, and so forth. An operating agreement can prevent problems down the road and can help maintain a smoothly operated partnership.

When considering an operating agreement, here are some of the more important things to think about.

1. Do you want the real estate company to be “member managed” or “manager managed”

In Connecticut, a limited liability can be set up as a “member managed” company or “manager managed” company. A member managed company generally requires the members to vote on taking action. A manager membered company is essentially set up so that a manager is vested with authority to run the operation of the company and the other members are more or less passive investors.

An operating agreement can be used to specially dictate what authority each member has in the day to day operation (e.g can unilaterally approve expenditures under $100) and what type of actions require a majority or unanimous vote (e.g. expenditures over $1,000 or the decision to sell or buy property). Similarly, an operating agreement can provide how a manager’s authority is limited and what requires a unanimous or majority vote of the members. Whether to make the company manager or member managed depends on the company.

2. Breaking a tie vote if two members

I have set up a number of limited liability companies for two member companies. While having a less amount of members may have a number of benefits, such as making decisions faster than larger companies, there is one issue that the two members must decide – what happens if there is a tie vote? This is something that each two member (or even number member investment team for that matter) should think about. One suggestion is if there is an individual that both trust, that individual can serve as a tie breaking vote.

3. Taking on new members

Another decision an investment team should think about is how the company will decide to take on new members. Perhaps the members do not want to allow the possibility of new members and if so such should be stated clearly in the operating agreement. If the members do want to allow the possibility of taking on new members, this should be stated in the operating agreement. If they do want to allow the possibility, the members should state what is required to take on new members (e.g. majority vote; unanimous vote, etc). This will prevent problems down the road.

4. Conveying a member's interest

Should each member be allowed to convey their interest without any restrictions? This could be problematic for a member who thought s/he would be working with other members. Therefore, it a good idea to clarify whether each member has the right to sell their interest without restriction or whether the other members should have the right of first refusal.

5.  Who is responsible for What / Who has Authority to do What.

Another very important thing to discuss is what members have the authority to do what. If every little action of the company required a majority or unanimous vote, it could make operating the company cumbersome. That is why it is a good idea to spell out what members can do without the other partners consent, typically the smaller stuff (e.g. contract with contractors for expenditures under $1,000, etc.) and what requires a unanimous consent (typically the larger stuff such as taking on a new mortgage or buying new real estate). The more detailed this part of the operating agreement, the less likely you will have problems down the road.

6. Duty not to compete?

Many investors have their hands in different things, many involving real estate. Sometimes, a partner can be a partner in a different real estate investment company. Do you and your partners want to have any restrictions on competition if a member owns interests in other companies? Maybe or maybe not. It is worth discussing with your partners.

@Mathew Patrick, you do not need to be an agent to lease out your space in your building. So if you purchase commercial buildings, you can enter into leases with companies or individuals for the space in your building. That is fine. However, if you want serve as the broker for commercial leases or even your building, and charge the tenant an additional fee for brokering the deal, I think you are acting as an agent and need a license. I am an experience commercial real estate attorney, feel free to ask me any questions.

Ed

WHAT MUST BE INCLUDED IN A HOME IMPROVEMENT CONTRACT?

I have had a number of clients who are both homeowners and contractors ask me to review a contract for home improvements (home addition, renovations, pool, deck, etc.) and request that I review the contract to make sure it contains all of the necessary information. They are surprised to learn that their contract is woefully deficient and in fact, may not be enforceable unless certain provisions are added. It is particularly important as a contractor to make sure your contract is enforceable by a court of law if you get stiffed for the final bill.

Under the Connecticut Home Improvement Act, all home improvement contracts must comply with nine (9) requirements in order to be enforceable. Court cases have ruled that failure to include some of the lesser important provisions will not render a home improvement contract unenforceable, but it is still a good idea to include all of these provisions.

The first statutory requirement is that the home improvement contract must be in writing and include the scope of services. Therefore, if you are a contractor, it is a good idea to take the time and have a standard written contract to use with clients and have it executed before you start work (although the scope of work will change). If you do not, it may be very difficult to enforce your agreement.

The contract must also be signed by the both the contractor and homeowner to be enforceable. This is a little bit different than standard contract law which only requires the signature of the party you are trying to enforce the contract against. The contract must also contain the company name of the contractor and registration number. The registration number ensures that the contractor is registered.

The contract must also contain a start date and completion date. Some contracts only include start dates and fail to include completion dates. This is a mistake. As a contractor, you want to include an estimated completion date. If you do not, and you do not get paid, the home owner may argue that it is not enforceable because the contract does not comply with law. On a related note, the contract must also contain the date of the transaction.

The law also requires certain provisions in the contract, including a notice of cancellation. The contract must also include a provision providing information about other ownership interests in other home improvement companies. These disclosures are important and failure to include them allows an argument that the contract is unenforceable.

In short, if you are a contractor doing any type of home improvement work, you should be aware that there are statutory requirements that must be included in each contract or you expose the company to an argument that the contract is unenforceable. The last thing you want is to make a demand for the final payment and to give the home owner an argument that they do not have to pay you because you failed to comply with the statutory requirements.

Conversely, if you are a homeowner in dispute with a contractor, you may have leverage if they don’t have the right contract.

 Great! Sounds like an interesting project and good luck!

 Several things come to mind to explore. Is this deed restriction enforceable? Ask your attorney to check the case law in your jurisdiction to see whether a court has decided whether this type of restriction that is in a sense in conflict with the zoning is enforceable. There may be an argument to make that is unenforceable.

Second thing that comes to mind - I believe there may be a way to petition the owners of the lots in the development to get a waiver. I have never encountered this specific issue but I recall reading cases about this a long time ago (10 years ago or so). You may need a certain amount owners in the development to approve a waiver.

Also, maybe there is something recorded by the developer in the land records that provides a procedure for getting a waiver.

Good luck, let me know how it goes.